Critique of “Production, Information Costs, and Economic Organization” by Armen Alchian and Harold Demsetz

Theoretical aspect:

What main theoretical contributions does the paper make? / What is the theoretical paradigm it seeks to advance?

• This article expounds on classical characterizations of the firm as a centralized, authoritarian entity or concept expected to yield productive outcomes often through autocratic means. Contrary to these characterizations, Alchian and Demsetz argue that the concept of the firm is based on a team-based contractual agent requiring cooperative and voluntary inputs from resource owners and employees (or suppliers), all of whom are input owners, in lieu of an authoritarian relationship between superiors and subjects. The article further explains the team process and why it prompts the necessity for the contractual form, the firm.

What are the core assumptions behind the authors’ ideas?

• Productivity does not automatically create its own reward. This in fact is reversed, according to Alchian and Demsetz. A particular type of reward stimulates a particular productive response (reward creates productivity.) Understanding this, it is essential, then, to appropriately measure both input productivity and rewards.
• Productivity levels and rewards are directly related. The firm, as it is a team-based system of economic organization, will operate best or yield its highest level of productivity when the right rewards are in place to facilitate high levels of productivity (or productive input) from input owners.
• A “metering problem” or measuring problem exists in team based production making it difficult to measure productivity and reward since team members own different inputs and are incented by different rewards.
• There is a benefit to a firm from working as a team, separate from what is derived from specialization of team members, that cannot be measured as the sum of the individual productivity of “cooperating inputs” or team members.
• Additionally, in this team based concept of the firm it is more expensive to attempt individually assess the productivity (or lack thereof) of individual contributors. Thus, input owners are more likely to shirk or not work optimally than if they were being individually monitored. Efficient procedures and organizations are required for monitoring the output of individual team members.
• There are specific types of organization systems that can lower the cost of monitoring the performance of individual team members. Market competition can do this by basing team membership and individual rewards on performance as observed by outsiders who would objectively speculate about individual member performance based on overall productivity and then revised teams with greater production would be formed. Specialization by a team member who serves as a monitor and is compensated via net earnings from the team would also reduce c